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Nevada ups the ante on Delaware's tax status

The US state of Delaware is an incorporation mecca where registering a company is as easy as 1-2-3. It draws not just the top firms, but also many shady shell companies. That has caught the attention of Nevada.

Back in the old days before Luxembourg decided to come clean and end its practice of banking secrecy that made it both wealthy and infamous around the world, Prime Minister Jean-Claude Juncker lashed out at what he considered unfair treatment of the grand duchy.

After G20 leaders announced a crackdown on global tax havens in 2009, Juncker said that if Luxembourg were to be listed as an international offshore finance center, then so should "Delaware and several other tax-friendly US states."

Juncker was not the only one pointing the finger at Delaware. That same year the non-profit group Tax Justice Network named Delaware the most murky global jurisdiction in it its Financial Secrecy Index, ahead of more well-known destinations such as Luxembourg, Switzerland or the Cayman Islands.

Taxes not major incentive

Delaware certainly has great allure. More than half of all US public companies and more 60 percent of America's biggest firms are incorporated in the second-smallest US state with a population of just 900,000. With good reason: the state levies no sales tax and no corporate income tax on most incomes for US companies. But Delaware's low tax regime is not the major reason why firms flock to the state, argue experts, since other states like Nevada have similar or even lower tax structures.

There's more to Delaware than meets the eye

"I don't think it's really fair to say Delaware is a tax haven," says Marcel Kahan, a law professor at New York University who studied Delaware's unique position among US states. While American companies can lower their corporate state tax load by moving from a high-tax state to Delaware or Nevada, this doesn't apply to foreign-based firms. "From an international perspective, the US is not regarded as a tax domicile, they have relatively high tax rates."

He also rejects the comparison between Delaware and other secret banking spots for a different reason: "Switzerland and Luxemburg are havens for people who want to have secret bank accounts," says Kahan. "Delaware doesn't have secret bank accounts, because that is regulated by federal law" and US law does not allow anonymous bank accounts.

Legal system sets Delaware apart

Delaware's major attraction for companies is that it is easy, fast and predictable to incorporate and run a firm.

"The main reason why they are going to Delaware is its convenience as opposed to any special international tax breaks companies get by incorporating there," explains Scott Dyreng, an associate professor of accounting at Duke University in Durham, North Carolina.

Registering a business in Delaware usually takes just days not weeks or months and does not have to be done in person. More importantly, Delaware has a special court system, the more than 200-year-old Chancery Court, which deals exclusively with corporate law.

Its sole focus on corporate law makes the court not only very efficient and fast in deciding cases, its long tradition of case law also gives companies the highest predictability and most advanced legal framework to conduct their business among all US states. As a result most US corporate law firms are trained in Delaware law.

While it may not be justified to call Delaware an international tax haven, it certainly is an incorporation haven - and unlike many countries in Europe it is possible and perfectly legal to set up a corporation in Delaware pretty much anonymously.

The US is an attractive place to set up shell firms

Due to these comparatively lax disclosure rules, one can organize a company in Delaware without naming the true owners of the firm. Once the corporation is formed, it issues shares and has shareholders and directors. But the names of the shareholders and directors are not necessarily publicly filed.

Lax disclosure rules

"In Germany if you have a company like a GmbH you have to list your shareholders and you have to have a minimum capital which you don't have in Delaware," says Kahan. "But you don't have to have that in the other US states either."

Delaware - like many other US states - provides more confidentiality and less control for corporations than most European countries, adds Kahan.

"The intriguing thing is that the General Accountability Office here in the United States in 2006 studied the disclosure rules and found that really Delaware was no different from any other US state," notes Dyreng.

But just as dozens of large, respectable companies like Delaware because of its good corporate law and tax system, many smaller and less-respectable firms and individuals like Delaware for the ability to set up so-called shell firms to run their murkier operations.

These shady shells have no tangible assets and no real operations, but serve only to conceal illegally attained funds. The most famous case is probably that of convicted Russian arms dealer Victor Bout who set up shop in the state. What is less known is that the he did not just use shell companies in Delaware, but also in Texas and Florida.

US attractive for shady shells

So it's not just Delaware that is a hot spot for shady shells. A large study released by the World Bank in 2011 found that of some 150 grand corruption cases from 1980 to date the US was used as a host for shell companies more than any other country.

Obama has forced Switzerland to come clean

For instance, according to the survey, DaimlerChrysler Automotive Russia SAO, in 2010 pleaded guilty to one count of conspiracy to bribe foreign officials and one count of bribery of foreign officials. The companies set up to make the improper payments were registered in seven different jurisdictions, among them the Bahamas, Cyprus, Ireland, the UK and California, Delaware and Florida in the US. What makes the US such an attractive destination for shady shells and dirty money is that the US - unlike many other financial secrecy hotspots - is generally not perceived as a dubious domicile for murky businesses.

Given this embarrassing record, why then has the US government which relentlessly pursued Switzerland until it finally gave up its financial secrecy laws not cleaned up its own house and outlawed the secret set-up of shell companies in the US?

Failed legislation

It has tried to do so - and failed. Since 2000 Senator Carl Levin - against opposition from business and state lobbies - has repeatedly introduced legislation that would force US states to register who really owns or benefits corporations. The last time the so-called Incorporation Transparency and Law Enforcement Assistance Act died in Congress was in 2011.

Many experts say that instead of implementing stricter laws what's actually happening is a race to the bottom. Nevada is the prime example for this trend: The state has tried to chip away at Delaware's lucrative incorporation business for a while, but realized that it couldn't compete with Delaware head-to-head due to the state's legal advantages.

Competition for shady corporations

"So the only way Nevada could compete with Delaware is by offering a different package and catering to a different niche," says Michal Barzuza, a law professor at the University of Virginia who published a paper on Nevada's rise as the place to set up shell corporations. Nevada, already a state with a solid track record in attracting shady businesses by offering lax laws in areas such as gambling or divorce, set out to carve itself a new market segment: "Catering to companies that want corporate law with almost no liability," says Barzuza.

As a consequence, the desert state has significantly decreased the liability that officers and directors of companies incorporated in Nevada are exposed to. Since 2000 it has established exceptions to liability that are prohibited in Delaware. In Nevada, there is no liability for duty of loyalty and no liability for breach of duty of good faith.